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Edited version of your written advice
Authorisation Number: 1051341786135
Date of advice: 23 February 2018
Ruling
Subject: Deductions under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)
The taxpayer sought a ruling on the deductibility pursuant to section 8-1 of the (ITAA 1997) of three payments and the application of section 82KK of the Income Tax Assessment Act 1936 (ITAA 1936).
Section 8-1 of the ITAA 1997
Section 8-1 of the ITAA 1997 states the following:
8-1(1) You can deduct from your assessable income any loss or outgoing to the extent that:
(a) it is incurred in gaining or producing your assessable income; or
(b) it is necessarily incurred in carrying on a *business for the purpose of gaining or producing your assessable income.
8-1(2) However, you cannot deduct a loss or outgoing under this section to the extent that:
(a) it is a loss or outgoing of capital, or of a capital nature; or
(b) it is a loss or outgoing of a private or domestic nature; or
(c) it is incurred in relation to gaining or producing your *exempt income or your *non-assessable non-exempt income; or
(d) a provision of this Act prevents you from deducting it.
* denotes a term defined in subsection 995-1(1) of the ITAA 1997
Even though the two paragraphs in subsection 8-1(1) set different tests for the deductibility, it is generally accepted that both paragraphs are not mutually exclusive (see John Fairfax & Sons Pty Ltd v. FC of T (1959) 101 CLR 30; 11 ATD 510; at 101 CLR 40).
Expenditure will satisfy the positive limbs of section 8-1 if its essential character is that of expenditure that has a sufficient connection with the operations or activities which more directly gain or produce the taxpayer's assessable income.
Whether a particular expenditure is deductible is a question of fact and characterisation. It involves an enquiry about what the expenditure was for and what it was intended to achieve in relation to the taxpayer's income earning activities or business from a practical and business point of view (Magna Alloys and Research Pty Ltd v FCT (1980) 49 FLR 183).
Taxation Ruling TR 2006/2 provides further guidance for the deductibility of service arrangements between associated entities. Paragraphs 18 to 22 provide an explanation for the general principles concerning the application of 'the positive limbs' of section 8-1 of the ITAA 1997 as follows:
● Expenditure will satisfy the positive limbs of section 8-1 of the ITAA 1997 if its essential character is that of expenditure that has a sufficient connection with the operations or activities which more directly gain or produce the taxpayer's assessable income.
● The characterisation of particular expenditure is by its nature a question of fact. It involves an enquiry about what the expenditure was for and what it was intended to achieve in relation to the taxpayer's income earning activities or business from a practical and business point of view.
● Ordinarily, the objective circumstances that gave rise to the expenditure would be expected to provide a clear explanation of the benefit intended to be achieved by the expenditure and thereby its essential character.
● Expenditure incurred in obtaining the supply of goods or services from another party under a contract will ordinarily be characterised by reference to both the contractual benefits passing to the taxpayer under the contract and the relationship that those benefits have to the taxpayer's income earning activities or business.
The Commissioner ruled that two payments are not deductible as the payments are directly connected to the ownership of shares and therefore not incurred in gaining or producing taxpayer’s assessable income nor it is necessarily incurred in carrying on the taxpayer’s business for the purpose of gaining or producing its assessable income.
In relation to the third payment, the Commissioner ruled that a portion of the third payment has been outlaid for non-income producing advantage and to that extend the expenditure is not an allowable deduction.
Section 82KK of the Income Tax Assessment Act (ITAA 1936)
Section 82KK of the ITAA 1936 operate to limit the availability of deductions in respect of losses or outgoings incurred between associated parties under arrangements that are designed to postpone the liability to tax on the amount receivable by the associate.
Section 82KK does apply in this case because the two payments are not deductible and the third payment will be included as assessable income by the recipient in the corresponding period.